When the plot was written for Sunnyvale's Cepheid, it was a classic tale of turning swords into plowshares. Founded in 1996, the fledgling biotech company took fast new methods of DNA analysis developed by a Livermore nuclear weapons laboratory and adapted them for lifesaving medical tests.

But ever since deadly anthrax powder was sent through the U.S. mail in 2001 and killed five people, Cepheid's story has turned more and more to its roots in bioterror defense work.

Cepheid's DNA analyzer is now the heart of a watchdog device that hovers near a big mail-sorting machine in Baltimore, taking big whiffs of air through a mechanical sniffer. The sniffer feeds the air and dust into the DNA detector,

which scans for the unique genetic signatures of killer germs. Results are available in as little as 30 minutes.

As a co-developer of that Bio-Agent Detection System, Cepheid is one of a number of biotech firms that have refocused some of their efforts to tap into the government's multibillion-dollar attempt to prevent and combat bioterror attacks.

The expanded federal budgets proposed for bioweapons defense this year couldn't have come at a better time for the biotech industry. Biotech share prices have sagged along with other sectors, weighed down by a tough economy, accounting scandals and the aftermath of the Sept. 11 terrorist attacks. Venture capital has dried up since 2000, when the sequencing of the human genome spurred a rush of optimism. The failures of once-promising drug candidates haven't helped.

But Cepheid's drive toward profitability could accelerate on the strength of its anti-bioterror projects.

RAPID FIELD UNITS

The company was thrust into the limelight after the anthrax attacks as one of the few companies producing rapid, accurate biodetection field units based on DNA analysis. Cepheid had developed unique improvements on Lawrence Livermore National Laboratory's fast-cycling technique for preparing DNA samples.

Federal agencies used Cepheid machines to detect the spreading anthrax contamination and identify its possible sources. The Army asked Cepheid to create other tests for plague and botulism germs. Then a leading defense contractor, Northrop Grumman, chose Cepheid as a partner to bid for a huge government contract to install germ detectors at post office sites nationwide. The group's pilot system is operating in Baltimore.

Although Cepheid has been steadily building revenue from its DNA-based diagnostic systems, the so-far profitless company could nearly double its sales if the Northrop-led bid wins the full contract for 1,500 biodetectors.

In the dismal financial climate of late, many biotech companies would have had little hope of shoring up their finances by offering stock for a quick hit of cash. But in the doldrums of August, Cepheid bucked the trend with a common stock offering that raised $10 million. Although Cepheid's main focus remains in medical testing and scientific research, buyers who sprung for the stock last summer had their eye on the promise of the Postal Service revenue, said analyst Winton Gibbons of William Blair & Co. Blair was the broker for the offering.

"Investors were focusing on the post office contract," said Gibbons, who does not own Cepheid shares. Another Cepheid stock issue raised $5 million last month.

VAXGEN REGROUPS

Another Bay Area biotech firm, suffering a major setback for its core product, is regrouping with a bit of help from an anti-bioterror grant. When Lance Gordon took over as chief executive of VaxGen less than two years ago, he had hoped to preside over the Brisbane biotech company's successful test of its AIDS vaccine. Instead, the large-scale test had limited overall success. But Gordon, who was hired to diversify the company, had hedged his bets.

A veteran of biotech collaborations with the military, Gordon led VaxGen's successful bid on a government contract to develop an anthrax vaccine. This year the deal will bring in more than $13 million to VaxGen and a partner, bolstering VaxGen's finances just as hope fades for near-term revenue from the AIDS vaccine.

"The fact that we have the anthrax contract right now means that a substantial amount of the heat, light, power and other operating costs of the company are paid for -- at a profit," Gordon said. "That is helping to support the company, without question."

VaxGen also has a chance to win a contract to produce 25 million doses of the new anthrax vaccine. Based on comparable deals, Gordon said, that could yield about $250 million in revenue.

Biotechnology industry associations say it's too soon to tell exactly how much anti-bioterror money could be available from the government.

The Bush administration is seeking $6 billion for Project BioShield, a 10- year effort to stockpile vaccines against bioterror germs. Millions of dollars in anti-bioterror requests are scattered through federal agency budgets to pay for everything from public health preparedness to food safety.

SOMETIMES A RISK

Going after government contracts could be a good move for companies like Cepheid that already have technology adaptable to defense work, Gollaher said. But some companies could be derailed if they divert scarce resources toward bids for bioterror work they may not win.

"Companies that don't have product revenues, don't have a strong cash flow, have to make strategic decisions on how to use their cash," he said.

Some of Cepheid's health care projects had to be put on hold during the past while the company worked with Northrop Grumman on the Postal Service bid, said Cepheid co-founder and Chairman Tom Gutshall.

"We said, 'If we do this, we're going to redeploy assets for a period of time,' " Gutshall said. "We knew we had to give up some things." But if Cepheid's luck holds, its biodefense efforts could pay off.

Even before the anthrax attacks, the Army's lead biological defense laboratory had been helping Cepheid fund development of its key innovation in DNA detection. Although Cepheid and other firms like Idaho Technology Inc. of Salt Lake City had built rugged portable field units that could quickly identify germs through automated DNA analysis, the samples still had to be prepared manually by a trained technician. But Cepheid's next-generation machine, GeneXpert, would have a built-in sample preparation process.

The GeneXpert system was also the clincher for Northrop Grumman, a major supplier of mail-sorting machines that recruited Cepheid for its bid on the post office contract, said Dave Tilles, the project manager.

"What Cepheid had developed was an instrument that automated the sample- preparation process so it could be used in an industrial environment," Tilles said. "That was really a technological shift."

The group's pilot Bio-Agent Detection System acquired a nose when another Northrop partner, Sceptor Industries Inc. of Kansas City, Mo., designed the mechanical sniffer. A fourth partner, Smith's Detection of Maryland, figured out how to integrate all the components.

Idaho Technology dropped out of the running for the post office contract, but the Northrop consortium survived an initial evaluation and won a preproduction contract to supply 19 machines. They may be installed by summer at 14 mail centers for testing in different climates throughout the nation.

Postal Service spokesman Bob Anderson said the system works so far, and chances look good that the group will win the contract to supply machines at 300 big distribution centers. The biodetectors are installed at the first point where sorting-machine rollers might expel contaminated dust. Investigators believe that's how two postal workers were fatally infected in 2001.

If the biodetectors sniff a deadly germ, the movement of mail through that center would be frozen while workers are evacuated. The search for a contaminated letter would be much easier than in 2001, Anderson said.

"It will not have spent three days going through the mail system, contaminating everything in its path, like the (letter sent to Sen. Tom Daschle) did," Anderson said. The 1,500 machines may be installed by next year,

he said.

Cepheid has estimated that it could have $14 million to $23 million in 2003 sales if the consortium wins the full contract this year. Cepheid would share total revenue estimated at about $200 million.

APPLIED BIOSYSTEMS' ROLE

Another Bay Area biotech firm would also benefit. Cepheid lined up Applied Biosystems of Foster City to supply reagents for the replaceable cartridges used in the detection units. The firms haven't disclosed financial details.

Flush from its success in developing a field unit for one customer's needs, Northrop is looking for other possible bioterror defense adaptations for the detectors, such as government contracts to protect key sites, or private contracts for train systems or stadiums. Cepheid's earlier systems have been sold to public health agencies, but the firm won't say if any of its products are being used by U.N. inspectors or U.S. military forces. Idaho Technology, its competitor in both bioterror defense and medical diagnostics, said its machines are being used by both the U.N. team and the military.

Analysts like Gibbons see the biodefense work as a timely boost for Cepheid that could support its long-term progress in the work it was founded to do.

With the bioagent detectors on track, Gutshall said, he's looking forward to concentrating again on Cepheid's core mission: Using quick DNA detection to help doctors, researchers, veterinarians and food safety inspectors. Future plans include quick DNA-based tests for cancerous tissue to aid surgeons in the operating room in removing every bit of a tumor. Another planned test would detect drug-resistant infections, so doctors can give the right antibiotic before waiting to see if standard treatment works.

"We are now swinging back," Gutshall said. "We want to get back to what our destiny was."